Equity Audit Procedures: Minutes, Stock Ledger, Issuances and Dividends

Equity looks quiet in most audits: a few lines, few transactions. That makes errors easy to miss and the documents easy to forget. The balances rest on corporate authority (board approvals), legal records (the stock ledger, cap table, charter) and cash. A good equity program connects all three. The rollforward format is covered in the statement of stockholders' equity rollforward guide. This post covers the testing.

Step 1: Understand the capital structure

Obtain and read the certificate of incorporation (or operating agreement), bylaws, shareholder agreements, option plans, and the cap table. Record:

• Classes of stock, authorized, issued and outstanding shares, par value.
• Preferences: liquidation, dividend, conversion, redemption features. Preferred stock with redemption rights outside the entity's control raises classification questions; see venture-backed startup audit preferred stock classification.
• Restrictions on dividends and repurchases in loan agreements.
• Rights of first refusal and buy-sell agreements, which can create liabilities.

Step 2: Read the minutes for the whole period

Every equity transaction needs authority. Read the minutes of the board and shareholders for the audit period and the time up to the report date, and list every item that affects equity: stock issuances, option grants, dividends, repurchases, conversions, capital contributions and distributions. Match each to the ledger. An authorization with no entry, or an entry with no authorization, goes on the open items list.

Request the minute book and confirm it is complete, including written consents. Missing minutes for a period are a finding.

Step 3: Test the stock ledger and cap table

Agree shares outstanding at year end to:

• The stock ledger or the transfer agent's report, which should be obtained directly where a transfer agent exists.
• The cap table, which should reconcile to the ledger.
• The general ledger shares and par value accounts.

If a transfer agent or registrar maintains the records, confirm shares outstanding directly. For privately held shares with no agent, inspect the ledger and test the certificates issued and cancelled. Note any shares outstanding that are not on the ledger.

Step 4: Test issuances

For each issuance, vouch:

• Board approval and the number of shares.
• The subscription agreement or purchase agreement.
• Cash received to the bank statement, or the noncash consideration to supporting documents with its valuation.
• Allocation between common stock par and additional paid-in capital.
• Issuance costs charged against proceeds.

For issuances for services, options and warrants, test the grant date fair value and the expense recognized under ASC 718 stock compensation. Review the 409A valuation or equivalent for support. See 409A valuation guide.

Step 5: Test repurchases and redemptions

For each repurchase, vouch the board authorization, the agreement, the payment, and the treatment as treasury stock or retirement. Confirm the price and consider whether the repurchase price exceeds fair value, which suggests compensation or a related party benefit. Repurchase obligations in agreements, such as put rights on employee shares, may be liabilities. See ESOP repurchase obligation.

Step 6: Test dividends and distributions

For each dividend:

• Board declaration date, amount per share, record and payment dates.
• Payment to the bank statement, in total and sampled by shareholder.
• Recording on the declaration date when declared, with a liability if unpaid at year end.
• Compliance with legal restrictions (state law surplus tests) and loan covenants on dividends.
• For pass-through entities, tax distributions to owners and whether they agree to the operating agreement formula.

A dividend paid but not authorized, and a distribution that violates a covenant, are the two exceptions to look for.

Step 7: Roll forward the accounts

Agree the opening to prior-year audited statements, each column to the testing above, net income to the income statement and the closing to the balance sheet. The $85,000 in "other" is stock compensation expense credited to APIC and agrees to the ASC 718 schedule.

Step 8: Test disclosures

The equity note and the statement show classes, shares authorized, issued and outstanding, par, preferences, dividends declared, repurchase activity, options and warrants, restrictions and related party equity transactions. Compare each to the minutes and agreements.

Worked example

A client records a $400,000 issuance of common shares to a new investor in November. The auditor:

1. Finds the board approval dated October 22 for 8,000 shares at $50.
2. Vouches the $400,000 wire to the bank statement of November 14.
3. Agrees the investor's name and shares to the ledger, which shows 8,000 shares issued November 14.
4. Sees that the books recorded $8,000 to common (par $1) and $392,000 to APIC. Correct.
5. Finds legal fees of $18,000 for the issuance expensed rather than netted against APIC. A reclassification entry is proposed, moving $18,000 from expense to APIC, because the amount is known and no judgment is involved. The roll-forward above is before that entry.
6. Notes that the investor holds more than 10 percent of the voting interests after the issuance, which makes it a principal owner under ASC 850, and updates the related party list. See related party procedures.

Documentation checklist

• Capital structure memo with sources.
• Minutes review summary listing every equity action.
• Ledger and cap table tie to the balance sheet.
• Vouching for each issuance, repurchase and dividend.
• Rollforward and tie to statements.
• Disclosure check.

CORAA prepares ready-to-review audit files for US CPA firms; the firm keeps the client, the review and the signature. See /us.

Sources

• AICPA, AU-C Section 500, Audit Evidence; AU-C Section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained
• FASB, Accounting Standards Codification Topics 505 (Equity), 718 (Compensation: Stock Compensation) and 480 (Distinguishing Liabilities from Equity)

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error